Sept. 2 (Bloomberg) -- The U.S. economy is so bad that the
chance of avoiding a double dip back into recession may actually
be pretty good.

The sectors of the economy that traditionally drive it into
recession are already so depressed it’s difficult to see them
getting a lot worse, said Ethan Harris, head of developed
markets economics research at BofA Merrill Lynch Global
Research in New York. Inventories are near record lows in
proportion to sales, residential construction is less than half
the level of the housing boom and vehicle sales are more than 30
percent below five years ago.

“It doesn’t rule out a recession,” Harris said. “It just
makes it less likely than otherwise.”

The possibility of the economy lapsing into another
contraction during the next year is 25 percent, he said in a
Sept. 1 report. Harris cut his forecast for growth this year by
0.1 percentage point to 2.6 percent and lowered his 2011
estimate by a half point to 1.8 percent, according to the
report.

Federal Reserve policy makers agree that a renewed
contraction is unlikely, although the risks have risen.

“I expect the economy to continue to expand in the second
half of this year, albeit at a relatively modest pace,” Fed
Chairman Ben S. Bernanke said in an Aug. 27 speech.

Rising Yield

The Standard & Poor’s 500 Index might increase to about
1,300, while the yield on the 10-year Treasury note would rise
toward 4 percent during the next six months or so if the U.S.
steers clear of another decline, said James Paulsen, chief
investment strategist at Minneapolis-based Wells Capital
Management, which manages $342 billion.

The S&P index closed at 1,080.29 yesterday in New York,
while the yield on the 10-year Treasury note was 2.56 percent at
8:59 a.m. in London today, according to BGCantor Market Data.

“We could have a really violent move,” Paulsen said.
“The markets have a lot of double dip priced in,” he added.
“I think the idea of that happening is pretty remote.

The risks of a renewed economic contraction have risen due
to a spate of disappointing economic data, said Lyle Gramley, a
former Fed governor who’s now a senior economic adviser for the
Potomac Research Group in Washington. He reckons the chance of a
relapse is 35 percent, up from 10 to 20 percent a month ago.

“We will probably avoid a double dip,” Gramley said.
“But we’re in for a prolonged period of subpar growth of 2
percent or less.”

Falling Orders

Orders for nondefense capital goods excluding aircraft, a
proxy for future business investment, fell 8 percent in July,
the biggest decline in one-and-a-half years, while sales of new
homes dropped unexpectedly to an annual pace of 276,000, the
lowest level on record, according to Commerce Department figures
released last week. The department also reduced its estimate of
second-quarter growth on Aug. 27 to 1.6 percent from 2.4
percent.

The unemployment rate probably rose to 9.6 percent this
month from 9.5 percent in July as employers reduced payrolls by
100,000, according to the median forecasts of more than 70
economists surveyed by Bloomberg News. The Labor Department is
scheduled to release the jobs data tomorrow.

Bernanke described the recovery in the job market as
“painfully slow” and said in his Aug. 27 speech at Jackson
Hole, Wyoming, that it had “damped confidence.”

‘Slow Pace’

“Things can get worse,” said Martin Feldstein, a
professor at Harvard University in Cambridge, Massachusetts, and
president emeritus of the National Bureau of Economic Research.
“When the economy is moving forward at a very slow pace, very
close to zero, the risk is we could slip over into the negative
side of zero.”

Feldstein served as chairman of the White House Council of
Economic Advisers from 1982 to 1984, around the time of the last
double dip in the U.S. He put the possibility of a contraction
at one in three and also voiced doubts about the Fed’s ability
to combat it, given how low interest rates already are.

“I think there is very little that the Fed can do,”
Feldstein, a member of the NBER committee that determines when
recessions start and stop, said in a Bloomberg television
interview on Aug. 27.

“With growth at a stall speed of 1 percent or below, the
stock markets could sharply correct, and credit spreads and
interbank spreads widen while global risk aversion sharply
increases,” said Nouriel Roubini, the New York University
economist who predicted the global financial crisis.

‘Negative Feedback Loop’

“A negative feedback loop between the real economy and the
risky asset prices can easily then tip the economy into a formal
double dip,” Roubini, chairman of Roubini Global Economics LLC,
said in an Aug. 25 e-mail message.

History argues against such a setback now, said Randall
Kroszner, a former Fed governor who is now a professor at the
University of Chicago Booth School of Business. Other industrial
nations that experienced major financial crises, such as Spain
in 1977 and Sweden in 1991, avoided double dips, though their
recoveries were slow.

Even Japan, which suffered a lost decade of minimal growth
after a real-estate bubble burst in the early 1990s, managed to
stage a three-year rebound before its economy was knocked back
down by the 1997-98 Asian financial crisis.

“My overview is that we have a very disappointing recovery
rather than a double dip,” said Carmen Reinhart, a professor at
the University of Maryland in College Park who co-wrote a book
on crises with Harvard professor Kenneth Rogoff.

Credit Controls

The only double dip in the U.S. since the end of World War
II occurred 30 years ago, when the economy turned up in mid-1980
only to fall back into recession a year later. That situation
isn’t applicable today, said Gramley, who was at the Fed at the
time. The initial decline in 1980 was triggered when President
Jimmy Carter imposed credit controls. He quickly reversed
himself when the economy collapsed in response.

Postwar recessions traditionally have been prompted by the
Fed boosting rates to fight inflation, oil prices rising sharply
or businesses suddenly reducing inventories, Gramley said. None
of that looks likely this time, he added.

The Fed cut the overnight bank lending rate to close to
zero percent in December 2008 and has signaled it intends to
keep it there for an extended period.

The central bank “will do all that it can to ensure
continuation of the economic recovery,” Bernanke said in his
Jackson Hole speech.

Falling Oil Prices

Oil prices have fallen as growth has slowed. Crude oil for
October delivery settled at $73.91 a barrel yesterday on the New
York Mercantile Exchange, down from the 2010 high of $86.84 set
on April 6.

The inventory/sales ratio for U.S. businesses was 1.26 in
June, just above its all-time low of 1.23 in March and April and
below 1.37 a year ago, according to Commerce data.

The housing market, whose collapse kicked off the economic
decline that began in December 2007, also looks to be
stabilizing at a depressed level, after factoring out the ups
and downs in sales prompted by a home-buyers’ tax credit and its
expiration in April, Paulsen said.

Residential construction totaled $358.1 billion at a
seasonally adjusted annual rate in the second quarter, compared
with $813.3 billion in the first quarter of 2006, at the height
of the housing boom, Commerce Department data shows.

‘Postponable Purchases’

What Harris calls “postponable purchases” -- housing,
spending on durable goods such as cars, and business investment
in equipment and software -- stood at 16.8 percent of gross
domestic product in the second quarter. That compares with a
postwar low of 16 percent in the same period a year earlier and
the post-war average of 20.6 percent, according to calculations
by Bank of America-Merrill Lynch.

“Even if they fall back down, you probably wouldn’t get a
recession; you’d get a period of stagnation,” Harris said.

Vehicle sales in the U.S. clocked in at a seasonally
adjusted annual rate of 11.46 million in August, off 32.4
percent from 16.95 million in August 2005, according to
statistics from Autodata Corp., a research company based in
Woodcliff Lake, New Jersey.

It would probably take a flare-up of the financial crisis
to push the economy back down and that’s less likely than it was
prior to 2007, said Jacob Frenkel, chairman of JPMorgan Chase
International in New York.

“The likelihood of a financial meltdown is now much lower
than it was in the past,” he said.

Banking Capital

The U.S. banking industry “has more capital as a
percentage of assets right now than in any time since 1935,”
Richard Bove, an analyst with Rochdale Securities in Lutz,
Florida, said in an Aug. 26 interview with Tom Keene on
Bloomberg Radio.

The positive yield curve -- with long-term interest rates
higher than short-term ones -- also argues against a fall back
into recession, according to Arturo Estrella, professor of
economics and department head at Rensselaer Polytechnic
Institute in Troy, New York. The yield curve has turned negative
prior to all of the last seven recessions, with no false signals
since 1967, his research shows.

Bernanke said in Jackson Hole that U.S. households have
also made “greater progress in the repair of their balance
sheets.” He pointed in particular to the rise in the personal-savings rate, which was 5.9 percent in July, compared with a 3.3
percent average since the start of 2000.

Fed policy makers have also highlighted the strength of
demand overseas as a plus for the U.S. economy, especially for
manufacturing companies.

Faster Pace

Manufacturing in the U.S. expanded at a faster pace than
forecast in August as the Institute for Supply Management’s
factory index rose to a three-month high of 56.3 from 55.5 in
July. Readings greater than 50 in the Tempe, Arizona-based
group’s index signal growth. The figure was projected to drop to
52.8, according to the median forecast in a Bloomberg News
survey.

“I tend to be cautiously optimistic about growth,” said
Harvard professor James Stock, who is also a member of the
NBER’s Business Cycle Dating Committee. “All the excesses have
been corrected.” A double dip is “quite unlikely,” he added.